Profitable Programming

The Stock

The Trade: AMC Networks (NSDQ: AMCX)–Buy < 39.

Why Now: AMC Networks stands to benefit from improved advertising sales on its strong 2012 lineup of programming and improved affiliate rates as the firm negotiates new deals with cable operators. The firm’s small market capitalization also makes it a candidate for potential takeover.

The Story

In the week between Christmas and New Year’s Eve, Yiannis headed to New York City with his family. Elliott’s favorite air carrier, US Airways, emailed him a special offer on a last-minute shuttle flight from Reagan National Airport to LaGuardia Airport. After pouncing on the deal, he calls Yiannis to deliver the good news.

Yiannis: Ne?

Elliott: Ne? What’s wrong with you? You live in an English-speaking country–don’t you think it’s time to say hello when you answer the phone? Anyway, what are you doing in my favorite US city?

Yiannis: The family and I flew up to New York City for a few days to relax and take in some culture. It’s a bit cold, but we’re having a good time. Since when did New York supplant London as your favorite city?

Elliott: New York is my favorite US city, though I’m sure the fine people of London, Ky., are tickled that you rate their city so highly. Actually, the US version of London is quite nice, but it’s hardly a major city. You might consider taking your family there next Christmas.

Yiannis: I’m sure my wife will be thrilled.

Elliott:  Anyway, let’s get down to business. What are you doing tonight?

Yiannis: Well, I had planned to take it easy.

Elliott: Wrong answer. Did you forget about Cocktail Stocks? You’re meeting me at 21 Club on 52nd Street. We’ll grab a drink there and then hit one of my favorite Italian restaurants, Cellini, for an 8 p.m. dinner.

Yiannis: Wait, you’re in New York? Didn’t you just get back from the UK?

Elliott: I’m in DC right now, but I’ll meet you for dinner and drinks if you can stop yammering and clear your schedule. My flight leaves at 2:00 p.m. I don’t like spending four hours on the train like you do.

Yiannis: I’ll see you at dinner.

Elliott: Great. I have an exciting stock for our first pick of 2012.

Yiannis: You bring the stock pick; I’ll bring my appetite.

Elliott throws a second suit into his overnight bag and calls a cab to take him to Reagan National. On the way there, Elliott books a hotel room in Midtown that’s slightly smaller than a closet.

Two and a half hours later, Elliott arrives at 21 Club, where he finds Yiannis at the bar with drink in hand. Elliott walks up and orders a martini.

Yiannis: Nice bar.

Elliott: You don’t recognize it?

Yiannis: I’m afraid I don’t.

Elliott: Haven’t you seen the original Wall Street? This is the bar where Gordon Gekko lectured Bud Fox about the finer things in life–steak tartare and fine suits. I always try to grab at least one drink here when I’m in New York.

Yiannis: Apparently, I haven’t seen Wall Street as many times as you have. What’s this stock you’re all excited about?

Elliott: Well, let’s talk about Madison Avenue, which is less than two blocks away.

Yiannis: Is that another movie?

Elliott:  Do you know why Madison Avenue is famous?

Yiannis: Well, I had a great lunch there yesterday at this place…

Elliott: Always with the food.

Yiannis: I’m just messing with you. I’ve lived in the US long enough to know that Madison Avenue is famous for its advertising agencies.

Elliott: Have you seen an episode of Mad Men?

Yiannis: Is that the show you and Roger were discussing the other day? You mentioned something about having whiskey and an ice bucket in your office at all times. I don’t want much television.

Elliott: Me either–with the exceptions of CNBC and Mad Men, a popular series that’s set at a fictional advertising agency. You should check it out. I know you’re a big fan of the early 1960s.

Yiannis: Thanks for the recommendation. What exactly does this have to do with your idea for Cocktail Stocks?

Elliott: Mad Men and other original content are the main reasons to invest in AMC Networks (NSDQ: AMCX), which was spun off from cable television operator Cablevision Systems Corp (NYSE: CVC) on June 30, 2011. The company’s flagship American Movie Classics (AMC) channel first went on air in 1984 and, for much of its 28 year history, screened classic films and syndicated television content such as I Love Lucy, The Golden Girls, The Little Rascals and The Three Stooges.  

Five years ago, the network shifted course, adding original programming to the mix. The AMC channel first aired the critically acclaimed series Mad Men first in July 2007. The show’s fourth season aired in 2010, with three more seasons slated for production.

Mad Men has garnered solid ratings in its first four seasons. The inaugural episode pulled in 900,000 viewers, while the first episode of the second season attracted 2 million viewers and the season three premiere had 2.8 million viewers. The first episode of the fourth season garnered 2.92 million viewers, while the show averaged 2.3 million viewers during the most recent season–roughly one-quarter more than in the prior season.

One of the most widely anticipated shows of 2012, the first episode of Mad Men’s fifth season will air in March. Yiannis, I’ll email you the exact date and time so that you can set your VCR to record it.

Yiannis: Very funny, man. Is the show really that good?

Elliott: If my impeccable taste isn’t enough to convince you of its quality, the 15 Emmy awards and four Golden Globes that the show has bagged should do the trick. That haul includes Emmys for the best drama series in each of its four seasons.

Yiannis: Sounds like Mad Men has been a success, although I had never heard of the show until earlier in the week. But why else should we make AMC Networks our first pick of the new year?

Elliott: AMC’s success hasn’t been limited to Mad Men. The program The Walking Dead, based on a comic book of the same name, has been an even bigger ratings success. The premiere of the show’s second season attracted 7.3 million viewers–a record for a dramatic series airing on basic cable. The Walking Dead also does incredibly well among viewers between 18 and 49 years old, a demographic that advertisers covet.

Yiannis: Is the show about the zombie banks in the financial sector?

Elliott: Close. The series follows the lives of a group of people that survived an apocalypse and are now living in a world inhabited primarily by flesh-eating zombies. The show is the most widely watched drama on basic cable. Other popular original series airing on the AMC channel include Breaking Bad, The Killing and Hell on Wheels, a new Western set in the 1860s. The network recently renewed the latter show for a second season after the premiere pulled in 4.4 million viewers.  

Yiannis: I haven’t heard of any of those shows. What about the company’s business performance?

Elliott: In the media business, content is king.

Yiannis: Ok, but how does the company make money?

Elliott: Cable networks make money through two main avenues: affiliate fees and advertising. Cable operators pay affiliate fees so that they can carry the network’s content on their system. Each month, subscribers pay their cable or satellite provider a preset amount for a package of channels. The provider, in turn, passes along a portion of these fees for the right to broadcast content from a certain provider. For example, the AMC channel currently receives an affiliate fee of about $0.26 per month per subscriber from cable providers, compared to a monthly fee of $0.60 per subscriber for the USA Network and $1.08 per subscriber for TNT. Affiliate fees are usually set in multiyear contracts and renegotiated upon expiration.

Advertisers also pay to air commercials on various networks, carefully analyzing the demographics of a show’s viewers to identify the programming that most closely matches the target consumer for their products. Mad Men and The Walking Dead are valuable properties because the series are particularly popular with key demographic groups.

Advertisers purchase airtime either in the up-front market or the scatter market. When purchasing commercial slots up front, advertisers pay for a certain amount of regular airtime months before a TV series hits the air. In the scatter market, companies book commercial time on a one-off basis during the season. Prices in up-front deals are usually lower because the advertiser is buying more airtime over a longer time frame.

Yiannis: Can you try to wrap up your lecture before we leave the bar? I want to enjoy a relaxing meal, not a TV dinner. Why should we make AMC Networks the first Cocktail Stock of the new year?

Elliott: AMC Networks should benefit from rising affiliate fees and advertising revenue. Affiliate fees accounted for 57 percent of the company’s 2010 revenue, compared to about 50 percent for Discovery Communications (NSDQ: DISCA) and about 30 percent for Scripps Networks Interactive (NYSE: SNI), the firm behind the Food Network and HGTV. Networks can grow their affiliate fees by expanding their distribution or increasing the rates cable companies pay AMC Networks per subscriber.

AMC Networks’ audience is growing modestly, largely because its flagship network is already carried by all major, multichannel cable distributors. In 2008 the company boasted about 94.5 million subscribers at year-end; by the end of 2010, the base had grown to 96.4 million.  

The firm continues to increase the affiliate fees it charges to distributors, a gradual process as existing contracts (usually four to six years in duration) expire. At the beginning of 2010, management noted that about 89 percent of all affiliate contracts would be up for renegotiation after the end of 2012.

Almost 90 percent of AMC Networks’ existing contracts were signed before Mad Men hit the air in 2007, when the network pursued its old model of rebroadcasting older movies and TV shows. The AMC Networks of five years ago is a much different beast than the AMC Networks of today, with the firm’s enviable lineup of original programming.

Although AMC Network has less bargaining power than behemoths such as News Corp (NSDQ: NWSA), Time Warner (NYSE: TWX) and Walt Disney (NYSE: DIS), the smaller network’s portfolio of highly rated and acclaimed shows should enable the firm to secure higher affiliate fees.

Management pegs the AMC channel’s value to distributors at roughly $0.75 per month per viewer–almost three times the current rate. This outlook may be a bit optimistic, but AMC should close the gap slowly between 2013 and 2015. The stock should begin to reflect this potential upside in 2012.

Yiannis: I imagine the company’s focus on affiliate fees makes the firm’s revenue a bit more defensive that some of its peers.

Elliott: You’ve actually listened to what I’ve said. AMC Networks generates about 60 percent of its revenue from affiliate fees, providing a stable source of cash flow. Advertising sales are for more volatile; in 2008 and 2009, for example, ad revenue plummeted when advertisers sought to reign in expenses and reflect lower demand.

At the same time, many US households regard basic cable as a necessity; even during recessions, consumer spending on cable TV remains relatively resilient.

Yiannis: What about the rest of the company’s growth story?

Elliott: AMC Networks’ three smaller channels–We TV, IFC and the Sundance Channel–offer more upside for distribution growth and affiliate fees.

We TV targets female viewers who are between 25 and 54 years old. The channel has about 77 million subscribers, up from 72 million at the end of 2008, and boasts several original series that have resonated with subscribers, including the reality shows Bridezillas and Braxton Family Values.

Unlike AMC Networks’ flagship channel, We TV has the scope to grow its audience as cable providers add the station to their basic-cable offerings. About 74 percent of We TV’s affiliate fees are up for renewal after 2012.

IFC, which airs independent films and alternative comedy series, targets viewers who are between 18 and 49 years old, a demographic prized by advertisers. The channel’s original comedy series Portlandia stars comedians from NBC’s long-lived Saturday Night Live and has attracted as many as 500,000 viewers for a single episode. Meanwhile, the channel’s Onion News Network–a satirical news show–has attracted similar-sized audiences. These viewership numbers pale in comparison to the numbers that Mad Men and other programs pull, but these shows also cost far less to produce.

With only 62 million subscribers and 81 percent of its affiliation agreements set to expire after the end of 2012, IFC has plenty of scope to grow its revenue.

Sundance Channel, AMC Networks’ smallest property, features independent films and has an ongoing relationship with the Sundance Film Festival. Although the station boasts only 41 million subscribers, this figure has grown substantially in recent years. The channel likewise boasts some successful programming, and 67 percent of its affiliate deals will expire after 2012.

I expect AMC Networks to leverage the popularity of its flagship channel to improve the distribution of We TV, IFC and Sundance Channel.

Yiannis: What about the advertising side of the business, which I imagine depends on the health of the economy?

Elliott: Advertising spending on cable TV should post solid growth in 2012. Cable TV is one of the most popular destinations for advertising dollars because of growing viewership and attractive demographics. Expect the medium to win advertising dollars from print outlets. Plus, advertisers still have room to bump up their budgets to normal levels. Unless the economy collapses outright–an unlikely scenario in the near term–advertising budgets should also remain healthy.

AMC Networks’ third-quarter conference call backs up this outlook. Management indicated that advertisers are waiting until the last minute to buy slots in the scatter market, a sign that they remain concerned about the strength of the economy. At the same time, the firm noted that pricing remains “quite strong” and that its fall up-front season went well.

In the first nine months of 2012, AMC Networks’ advertising revenue had surged 12 percent from year-ago levels.  Although third-quarter ad revenue was flat on a year-over-year basis, the programming schedule over this period makes for difficult comparables because it featured less original programming.

In the near term, advertising sales should drive revenue growth; AMC will air 20 percent more original programming in 2012 than it did in 2011. Highlights from the first quarter include the final episodes of the first season of Hell on Wheels and the second half of The Walking Dead season. The fifth season of Mad Men will air toward the end of the first quarter and will continue to run through the second quarter.

In contrast, AMC aired no original series in the first quarter of 2011. The first season of The Walking Dead finished in 2010; Hell on Wheels didn’t debut until late in 2011; and Mad Men went on a prolonged hiatus in 2011 because of a contract dispute between AMC and the series’ creator, Matthew Weiner.

With more original programming and even stronger ratings than one year ago, AMC Networks could surprise to the upside in the coming year. The stock could also run up in anticipation of a strong premiere for the fifth season of Mad Men, which fans have awaited for some time.

AMC should also benefit from digital-delivery deals. Mad Men and some of AMC Networks’ early original programming were produced by third-party studios and licensed back to AMC under long-term deals that give AMC exclusive rights to air the show. Some of these deals allow AMC additional distribution rights–for example, for streaming by Netflix (NSDQ: NFLX)–though the terms of these agreements are less favorable.

But AMC Networks owns all the rights to The Walking Dead and recently signed a deal granting Netflix exclusive rights to stream the series. Although neither company disclosed the exact terms, AMC Networks should enjoy better margins on content over which it has more control.

Yiannis: Makes sense to me. I may even watch some of AMC Networks’ shows.

Elliott: I’m not the only one who likes AMC Networks; the company could be a takeover candidate for a larger media firm seeking the rights to AMC’s original programming. The value of all AMC’s stock and debt is less than $5 billion–an easy mouthful for a giant like Time Warner, which has a market capitalization of $37 billion. Such a firm should be able to squeeze additional value out of AMC Networks because of its bargaining power when negotiating affiliate fees.

The next major catalyst for AMC Networks will be its fourth-quarter results and ratings for Hell on Wheels, The Walking Dead and Mad Men. With decent growth in ad revenue, shares of AMC Networks could surge to between $45 and $50. In the event of a takeover, the stock could fetch at least $50 per share, about a 35 percent premium to the current price.

The stock has also exhibited significant relative strength in the weak market and has formed a strong base around $38. AMC Networks rates a buy under 39.

Updates on Open Positions

August 2010: Vale (NYSE: VALE)–Buy < 30

The price of iron ore remains range-bound and could remain volatile for sometime because of uncertainty about economic growth. That being said, Vale’s long-term growth story remains intact and the stock’s current valuation makes for an attractive entry point. The stock’s near-term performance will hinge on China’s economic growth and EU efforts to address the Continent’s ongoing sovereign-debt crisis.

September 2010: Teekay Tankers (NYSE: TNK)–Buy < 10

A 28 percent yield is Teekay Tankers’ only saving grace. We have been in this trade long enough that all the bad news has been priced into the stock–including lower day-rates on the spot market. The company relies less on very large crude carriers, a segment of the seaborne transportation market that continues to suffer from massive overcapacity. 

November 2010: True Blue (NYSE: TBI)–Buy < 15

Business continues to trend upward, and the company has performing much better than its peers. True Blue has a net cash position and grew its sales 19 percent in the most recent quarter. Although activity in the residential construction market, the nonresidential has been doing well as has been manufacturing.

Our investment thesis for TBI remains intact. Part-time employees will account for a greater proportion of the US labor market. The company’s business continues to strengthen, as indicated by new contracts and stronger US employment numbers.

February 2011: ProShares UltraShort 20+ Year Treasury (NYSE: TBT)–Buy < 30

Betting against US Treasury notes has been a losing proposition. This position could recover some lost ground when investors rotate funds from safe havens to equities, which should happen sooner rather than later.

May 2011: TAL International (NYSE: TAL)–Buy < 32

The container leasing business remains solid despite macro concerns, with utilization rates at elevated levels because of tight supply of used containers. New container inventory is at normal levels, and demand for new ones could pick up early in the year.

TAL International is the top company in the container shipping industry, and the stock will rally if global trade doesn’t collapse. We continue to monitor the situation closely.

June 2011: iShares MSCI Italy Index (NYSE: EWI)–Buy < 15

This play on Europe’s turnaround is less risky than our Greece-related bet. The Greek experiment has forced the EU to deal more decisively with Italy’s fiscal challenges. Italian equities could rally once the country’s financial situation stabilizes.

July 2011: TransGlobe Energy Corp (NSDQ: TGA)–Buy < 12

Egypt’s government will allow TransGlobe Energy to increase its presence in the country. The new fields should add around 4,000 barrels of oil output per day. The company now produces about 12,000 barrels of oil per day and has 2,250 barrels per day shut-in indefinitely in Yemen. The company plans to spend USD70 to USD90 million on exploration and development in 2012, and expects to grow product to between 16,000 and 20,000 barrels per day.

The stock has pulled back because of political uncertainty in Egypt and Yemen and will remain volatile. This speculative stock tends to outperform bull markets and underperform in bear markets.

July 2011: Market Vectors Gulf States Index (NYSE: MES)–Buy < 23.50

This exchange-traded fund has held its own since we featured it in the July issue, especially given the performance in the global markets over the same time frame. We’re holding out for a powerful upsurge.

August 2011: National Bank of Greece (NYSE: NBG)–Buy < USD5

This stock is our most speculative play to date and is only appropriate for aggressive investors who can stomach a bet that’s based solely on a turnaround in Greece. A resolution to Greece’s sovereign-debt crisis is far from a foregone conclusion, though steps are being made to the right direction.

National Bank of Greece may try to raise about USD1.3 billion by issuing preferred shares, a positive step that should offset some of its inevitable writedowns.

September 2011: China Cord Blood Corp (NYSE: CO)–Buy < 4

In China Cord Blood’s recent quarterly results, revenue rose by 19 percent, with earnings up 29 percent year over year. Subscribers to the firm’s services grew by 8 percent on a quarterly basis, while expenses declined.

Don’t let near-term volatility shake you out of this stock; this bet will pay off over the longer term.

October 2011: Infosys (NSDQ: INFY)–Buy < 55

Infosys acquired an Australia-based company, Portland Group, for USD38 million. Portland generated about USD32 million in annual sales and boasts three offices in Australia and presence in China. Portland was set up as a consulting company in 1999 and added management services and global sourcing to its portfolio in 2007. Infosys Australia has annual revenue of about USD300 million and approximately 650 employees.

Investors should adhere to our buy target and only add to their positions when the stock trades below 55.

November 2011: Melco Crown Entertainment (NSDQ: MPEL)–Buy < 12.75

This casino and hotel operator remains the best way to gain exposure to the lucrative gaming market in Macau. The firm has USD1 billion in cash on its balance sheet. The company recently listed its shares in Hong Kong in an effort to increase its investment base in Asia.

Melco Crown Entertainment’s market share has grown considerably, especially in the mass-market segment. The firm remains one of the leaders in serving the high-roller segment.

December 2011: Symantec Corp (NSDQ: SYMC)–Buy < 17.50

Management has said that the company may purchase some of its stock at current prices. With USD2.3 billion in cash, Symantec Corp is also looking for acquisitions in its core markets of security and storage.

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